Blueprint Problem: Using Variances for Control-Investigating Variances and Control Limits

When to Investigate Variances

Calculating the variances is just a preliminary step. The important question is what do we do next? There are two possibilities - ignore the variance or investigate it. Relatively small variances are expected and managers do not need to look into them. For example, suppose that a factory bought $5,000 of raw materials and the standard cost was $4,990, resulting in a $10 unfavorable variance. Is $10 important? Probably not. The company expects raw materials to vary in price a little bit from month to month. Similarly, suppose $4,980 had been spent, resulting in a $10 favorable variance. Again, the $10 variance is probably not worth worrying about. However, suppose the factory paid $5,500 for the raw materials? Now the variance is $510 unfavorable and is more than 10% different from the standard cost of $4,990. This may well prompt an investigation.

There is no accounting rule on when to investigate variances. Instead, each company follows its own guidelines. These guidelines may involve an absolute dollar amount, such that any variance that is more than $600, for example, is investigated. Or, the guideline may be based on a percentage of standard, such that any variance that is more than 5% different from standard, for example, is investigated. Finally, there may be a two-part guideline, e.g., investigate all variances that are more than $500 or 10% different from standard.

Example: Batten Company provided data on product cost variances for the past month. Fill in the variance amount and direction (Favorable, Unfavorable or Not applicable):

Enter all amounts as positive numbers.

Type of Variance	Actual		Standard		Variance
Materials price variance	$24,600		$23,400		$
Materials usage variance	35,000		35,900
Labor rate variance	15,000		15,000
Labor efficiency variance	15,300		14,500
Variable overhead variance	5,950		5,800
Fixed overhead variance	5,800		6,200

Batten's policy is to investigate all variances that are either more than $1,000 or 5% more than standard. Which variances should be investigated and why? Select "Yes" if the variance is "more than $1,000" or "5% more than standard" else select "No" to explains why Batten would investigate.

Type of Variance	more than $1,000	more than 5% of standard
Materials price variance
Materials usage variance
Labor rate variance
Labor efficiency variance
Variable overhead variance
Fixed overhead variance

Which of the following statements is true?

Responsibility for Variances

In accounting, responsibility is attached to whoever has the best information regarding a situation. In variance investigation, the manager starts first with the department that knows the most about the issues surrounding the variance. For example, the role of the Purchasing Department is to purchase materials and, as a result, it is responsible for any direct materials price variance. This department is most familiar with the reasons for any price difference from standard. The production supervisor is most familiar with the reasons for labor efficiency or inefficiency. This does not mean that these departments are "to blame" for the variance. Recall that variances are tagged "favorable" or "unfavorable" but that these labels do not mean "good" or "bad." Instead, they just indicate the direction of the variance from standard.

In investigating the materials price variance, a manager would go first to the .

In investigating the materials usage variance, a manager would go first to the .

In investigating the labor rate variance, a manager would go first to the .

In investigating the labor efficiency variance, a manager would go first to the .

A large unfavorable materials usage variance coupled with a large favorable materials price variance could mean .

In the above case , who is responsible? . A large unfavorable labor rate variance coupled with a large favorable labor efficiency variance could mean .

Overhead variances depend on the line items that are out of line. A manager could review each item to see if one was particularly higher or lower than standard and talk with the department in charge of that item. For example, higher than standard receiving costs would send the manager to the supervisor of Materials Stores and Receiving. Lower than standard engineering costs would send the manager to the Engineering Department.

Control Limits

Management accountants can determine which variances to investigate by using control limits. This is a graphical method of viewing whether or not an observation is "in control" - that is, it is within allowable standards - or "out of control" - outside the standards. The upper control limit is the standard plus the allowable deviation. The lower control limit is the standard minus the allowable deviation. Then the actual amount is compared to the control limits. If the actual amount is within the control limits it is . If the actual amount is outside the control limits then it is .

Example: Forster Company gathered the following information on overhead costs for seven months:

Month		Actual Overhead		Variance
June		$87,500		$
July		90,200
August		100,500
September		81,300
October		89,400
November		95,000
December		93,600

Standard cost of overhead in each month is $90,000. The allowable deviation from standard is 5%. Fill in the variance amounts for each month in the above table.

The upper control limit for overhead for Forster Company is $. The lower control limit for overhead for Forster Company is $.

A chart of overhead versus the upper and lower control limits is shown below.

Based on the chart, which of the following month's actual overhead appear to be out of control? Is the overhead above the upper control limit or below the lower control limit? Select "Yes" or "No".

Month		Above upper control limit	Below lower control limit
June
July
August
September
October
November
December

If Forster Company tightened the control limits by allowing only a 3% deviation from standard, it would result in months being out of control.